This paper was submitted in partial fulfillment of the requirements for the
Master of Business Administration (MBA) degree at the Maastricht School of
Management (MSM), Maastricht, the Netherlands, August 2011.

Contents

Abstract

"Peer-to-peer lending (p2p-lending) platforms facilitate financial transactions (lending and borrowing) between individuals without the intermediation of a traditional financial institution. It is an unsecured decentralist
financial service. P2p-lending platforms offer lenders the potential to earn higher returns than conventional banks and may offer borrowers broader access to credit. Although researched on a case-by-case basis by Herzenstein (2008), Freedman (2008) and Berger (2009) little has been written until now about the fundamental shift p2p-lending causes in terms of regulation, trust and user centred financial services . This
thesis therefore focuses on three areas within the online p2p -lending services:

1) The need of trust in financial services;

2) The importance of peer-production structures in p2p-lending; and

3) The need of new government imposed banking regulations for p2p-lending.

This study explores patterns of trust and identifies variables that contribute to trust or decrease the level of trust in financial services. It aims to identify causal relations among the identified variables that contribute to a tangible and measurable equation for trust in p2p-lending.

This framework is tested via qualitative research and empirical observation and the collection of data via a comparative case-study analysis of two leading p2p-lending platforms (Zopa and Prosper) and a quantitative Internet mediated survey of 102 respondents. The major research question: “What are the regulatory and the market requirements to co-create a trusted online peer-to-peer lending platform for consumer credit in the Netherlands? is derived from the conclusions to seven minor research questions. Based on a trust model that encompasses four dimensions (reliability, openness, competence and concern) eight variables are identified that can be measured on a scale of 1 to 10.

This results in the following ROCC trust equation for p2p-lending:

The study concludes that:

1) The minimum acceptable level of trust in a p2p-lending platform in the ROCC formula should at least be a score of 48.

2) Despite the credit, operational and legal risks associated with p2p-lending, the government should only play a moderate role to regulate and control the sector.

3) There is a trend discernible where users of financial services slip away from a ‘blind trust’ in the financial sector to a dangerous low level of trust. P2p-lending contributes to more user oriented services that can create ‘smart trust’.

4) A break-even point for a p2p-lending platform in the Netherlands is possible at 11.000 transactions per year. This means such a platform is feasible and viable at a minimum market share of 1,25%.

5) A p2p-lending organisation model should be based on a triangle structure that places the p2plending provider in the middle and is built on three pillars: ‘users’, ‘values & trust’ and ‘tools’."

Excerpts

Business Models of P2P Lending

"The business model of p2p-lending is quite straightforward: the platform asks a nominal fee of around !100 per transaction or a percentage of the loan amount to cover its costs. Based on numbers from various p2plending platforms, the table below indicates that p2p-lending customers potentially can save a considerable amount of money when compared to trustworthy other credit providers in the Netherlands (in this case OHRA and ABN-AMRO). The table shows that the average lender customer (CBS, 2011) that concludes a loan of !10.000 in 60 instalments can save more than !1.000 at a p2p-lending platform. This amount can vary depending on his/her credit risk profile and the associated interest rate."

Characteristics of p2p-lending

"Let us look at some more specifics and characteristics of the p2p-lending service for most platforms:

- The provider gives a service to the lenders by giving them a platform where they can subscribe to
loans of categorised borrowers according to a risk profile.

- The platform authenticates the identity of each borrower and lender and extracts the borrower’s
credit history, and posts credit grades in the borrower’s listing.

- The provider realises a contract between a group of lenders and a borrower.

- The platform plays an intermediary role when entering into financial transactions between (a pool of)lenders and borrower and is responsible for the contractual basis of the transaction, the execution,the collection of interest or dividends for the lenders and in the case of a loan repayment default thehiring of a collecting agency.

- Borrowers repay monthly by direct debit. If any repayments are missed, a collections agency uses
the same recovery process that other banks use.

- Many platforms encourage borrowers and lenders to form online groups and establish social network
(Facebook, Twitter, MySpace) relationships with other members. It allows members to give
endorsements for a specific listing.

- P2p lending providers ask a nominal fee per contract of ! 100 to ! 150 or a percentage of the loan
amount to be paid by the borrower. Lenders of some platforms pay an annual servicing fee of around
1%.

...

According to the authors Hulme (2006), Freedman (2009) and King (2010), these characteristics effectively mean that the online p2p lending market replaces the bank as the intermediary and enables decentralised unsecured online transactions between borrowers and lenders. In King’s already mentioned “Bank 2.0: How customer behaviour and technology will change the future of financial services”, a view of the future of retail
banking is presented and linked to changing customer behaviour. Customers are changing, according to
King, because of the psychology of self-actualisation and technology innovation and adaptation. (2010, p.41) P2p-lending is an outcome of this changing customer behaviour and so far p2p-lending platforms fulfil an increasing demand and now serve more than 4.000.000 users worldwide (Zopa, Prosper & Ppdai, 2011) although their outreach has been limited to a few countries (including China, Japan, UK and USA)."

P2p-lending market in the Netherlands

"Current market size in the Netherlands for consumer
credit contracts is 3.500.000. On average these
contracts have a maturity of 4 years, which means that
approximately 875.000 new contracts are concluded
on a yearly basis. (CBS, 2011)

The first Dutch p2p-lending platform to emerge on the market was Booper. It started operations in 2007 and it had a total of !1,4 million in outstanding loans after a few months in operation. The Dutch Authority for
Financial Markets (AFM) then decided to temporarily suspend Booper’s activities because it operated without a banking license. After analysing Booper’s business model vis-à-vis the regulatory framework, the AFM
decided Booper could continue under the condition that a lender can invest a maximum sum of ! 40.000
divided over a maximum of 100 loans (maximum ! 400 per loan). However, The Dutch government
implemented new regulation in November 2007 that levelled the rules for private loans with the regulation of consumer credits in the commercial market. (Rijksoverheid, 2007) The business model for Booper turned out
to be unsuccessful within this new framework and the company went bankrupt in 2009. Many lenders lost the larger part of the money they provided to loans on the platforms.6 It was only at the start of 2011 that three
new p2p-lending platforms started in the Dutch market: http://mkbcrowdfunding.symbid.nl,
www.geldvoorelkaar.nl and www.crowdaboutnow.nl All platforms only have a limited reach so far in terms of users and the number of transactions. However, the start of these platforms reintroduced the topic of p2pregulation
in the Netherlands. The next section will discuss the issue of regulation in more detail."

The risk of unsecured loans

"As mentioned, p2p-platforms operate with unsecured loans. How risky are these services? Recent figures on ‘Bad debt’ from the p2p-lending platform Zopa illustrate that the realised bad debt within the Zopa platform in
the last twelve months was 0,14%. (Zopa, 2011) Since inception of the platform the actual default levels have always been lower than the expected bad debt. However, these figures should not be taken at face value as they were provided by the Zopa platform and could not be checked on the criteria used to qualify a
loan or borrower as being in default. Actual loan default and loss rates may be different than expected, because the platforms have limited historical loan performance data, and their credit rating systems may not
accurately predict how loans will perform. (GAO, 2011) Another point of interest from a lender perspective is that individual lenders on p2p-lending platforms are by definition less professional than financial institutions.

They may not have the expertise to qualify associated risks in advance and during the monitoring phase after a contract has been signed. This means that the operational risk at p2p-lending is perceived higher than a standard savings account at a traditional bank.
The described credit, operational and legal risk seems to justify a regulatory role for the government in p2plending.

Others however argue that such intervention from the government would stop this innovation in the
banking industry. Banks have the choice to either try to reinforce traditional mechanisms and behaviours or to transform their operations and services to a more user oriented model. King refers in this respect to ‘value
innovation’, which means that banks should create superior customer value with a view of gaining a
competitive advantage. In the dynamic Internet based landscape continuous improvement of the customer collaborating with the customers. (King, 2010, p. 51)"

Characteristics of Trust

"In 1996 Aneil Mishra designed a model of trust that addresses four dimensions of both individual and organizational trust. These dimensions create a perception of trust based on one party’s willingness to be
vulnerable to another party based on the belief that the latter party is:

1. Competent: trust can only be created if one party has confidence in the knowledge, skills and
abilities of the other party.

2. Concerned: the demonstration of interest and care in the well-being of others.

3. Open: stakeholders must trust industry leaders to be open and honest about strategy, intent and
purpose.

4. Reliable: consistency of words and actions.

From a company perspective, the first two dimensions seem to be primarily related to human behaviour and human resources, while the latter two relate to corporate operations and corporate strategy. (Mishra, 1996)

Ten years after Mishra’s article was published, this framework was further built upon in Stephen Covey’s influential book ‘The Speed of Trust’. (Covey, 2006) The book presents a road map to establish trust on
every level (personal, relational, organisational, market and at the level of society) from an inside-out approach.

He brings trust from an intangible and unquantifiable variable to an indispensable factor that is both tangible and quantifiable. (King, 2006, p. 13) When trust in a company is in a downward slope, speed in the in any
organisational process slows down and costs increase. On the other hand, when trust increases, the speed of the process will gear up and the production and operational costs decrease.
Covey claims that trust, regardless of its status as high or low, is the hidden variable in the formula for organisational success. Figure 9 below states the traditional business formula and afterwards includes the trust variable (T).

Trust, when high, can function as a performance multiplier, but when low, it can function as a performance decreaser, even if strategy and execution are in good order. According to a poll in 2003, 39% of individuals
said they would increase their business with a company specifically because of trust, while 83% stated that they were more likely to give a company they trust the benefit of the doubt. (2006, p. 266) These figures support Covey’s formula and it will be interesting to see how financial service providers can incorporate this
formula in their business strategy."